Investing, Asset Allocation, Economics & the Search for the Bottom Line

US Economic Profile | 1.20.14

The economic news of late has been a bit wobbly—the surprisingly weak pace of jobs growth in December, in particular. But letting the tail end of a handful of numbers (that may or may not be revised) is a dangerous game for drawing strategic conclusions about the overall state of the economy. On that note, let’s move a bit closer to the realm of robust analytics and note that there are still no convincing signs of trouble for the business cycle when we look at the broad macro trend across a diversified set of 14 economic and financial indicators.
The December numbers for the US Economic Trend and Momentum indices (ETI and EMI, respectively) remain at levels associated with growth and the near-term projections suggest more of the same. As always, the data may tell a different story tomorrow. But for now, the hard numbers show that the economy’s forward momentum is intact. When and if this changes in a convincing way, you’ll read about it here. Meantime, here’s what the numbers across the board are telling us now.

ETI and EMI are at levels that are well above their respective danger zones through December 2013, which is nearly complete in terms of a full set of published monthly data. Although ETI and EMI are off their recent highs, both benchmarks are still firmly in positive territory and so they continue to reflect an expanding economy. Recession risk has been minimal for over four years, according to these business cycle indicators, and there’s still no sign that this favorable trend is about to end. It may be somewhat easier to imagine otherwise, depending on where you’re looking or the analyst du jour. But as history reminds, it’s best to let the numbers tell you when to worry. Yes, there’s a caveat: If we’re looking for relatively reliable and convincing signs of trouble for the business cycle, the warnings will come shortly after the cycle has peaked. It’d be nice if we could convincingly forecast these turning points in advance—before we have supporting data. But the track record on this front is poor—poor enough so that looking much more than a month or two out is the macro equivalent of guessing, which yields the usual results. That leaves us to focus on the next-best model—nowcasting the state of the business cycle in real time, and frequently updating the numbers for the earliest possible sign of a change in the cyclical weather. That yields quite a lot of strategic information relative to what passes as the usual fare, but that’s a story for another day.

With that in mind, here’s the latest monthly view (the weekly numbers and analytics are available as a premium service, by the way). Let’s start with the individual indicators that collectively dispense a big-picture review via ETI and EMI. For the moment, the only sign of potential trouble: oil prices, which are up 11% or so on year-over-year basis through last month (shown in the table below as a negative reading because these comparisons are inverted so that the price changes align with the signals for the other data sets).

Reviewing ETI and EMI in historical context shows that both benchmarks remain well above their respective danger zones: 50% for ETI and 0% for EMI. If one or both indexes fall below their respective tipping points, that would be a warning that recession risk is elevated.

Translating ETI’s historical values into recession-risk probabilities via a probit model also suggests that business cycle risk is low.

For some perspective on how ETI’s values may evolve as new data is published in the near future, let’s review projected values for this index with an econometric technique known as an autoregressive integrated moving average (ARIMA) model, based on calculations via the “forecast” package for R, a statistical software environment. The ARIMA model estimates the missing data points for each indicator, for each month through February 2014. (October 2013 is currently the latest month with a complete set of published data). Based on the projections, ETI is expected to remain well above its danger zone in the near term. Forecasts are always suspect, of course, but recent projections of ETI for the short-term future term have proven to be relatively reliable guesstimates vs. the full set of monthly reported numbers that followed. As such, the latest projections (the four purple bars on the right in the chart below) offer some support for cautious optimism. For comparison, the chart below also includes ARIMA projections published on these pages in previous months, which you can compare with the complete monthly sets of actual data that followed, based on current numbers (red circles). The assumption here is that while any one forecast is likely to be wrong, the errors may cancel one another out to some degree by aggregating a broad set of forecasts into ETI.

For additional context for judging the value of the forecasts, here are previously published ETI and EMI updates for the last three months: